Information Exchange in Profit Shifting

Abstract

Multinational enterprises form long value chains linking subsidiaries and affiliates in many countries. Some governments provide tax preferences which may distort the rightful profit distribution over the value chains. This profit shifting is elusive for the involved countries because no government has a complete view of the multinationals' business activity. Hence, intergovernmental communication becomes a chief concern for counteraction to harmful tax competition and aggressive tax planning. To investigate the issue we developed a novel sequential no-action Bayesian persuasion to model intergovernmental information exchange for tax matters. This communication model reveals how information asymmetry governs global profit allocation and naturally highlights the role of offshores in covering up aggressive tax planning. We explain a mechanism that connects quality of communication with tax policy and taxpayers' ability to misreport profit. The main outcome is that identically informed governments and high misreport costs can impede profit shifting.

Keywords: tax avoidance, Bayesian persuasion, profit shifting

JEL Classification: D82, H26, H77